Optimistic investors have bid up the share prices of Eli Lilly and Company (LLY) ahead of its fiscal second quarter earnings report. At first glance, it appears that option traders are anticipating a positive move, as there are a high number of put options being sold in the open interest. This unusual option trading may create a downward trend in the price action if LLY delivers a negative earnings surprise.

A notable number of put options remain in the open interest for LLY, and option premiums are elevated right now. Option trading volumes indicate that traders have been buying calls and selling puts in anticipation of a positive earnings report. If these bets were to unwind, it could result in unexpected downward pressure on the share price of Eli Lilly.

It is difficult to accurately predict the direction a stock will move after earnings. However, a comparison between the stock's price action and option trading activity shows that, if Eli Lilly delivers a negative report, the company's share price could fall significantly, moving closer to its 20-day moving average in the days after the announcement. This is possible because options are priced for an upwards move, but unexpected poor news could catch traders off guard and create a rapid decline in share price.

Key Takeaways

  • Traders and investors have bid up Eli Lilly share prices to an extreme range headed into the earnings announcement.
  • The share price has been closing well above its 20-day moving average.
  • Call and put pricing is predicting a stronger upwards move.
  • The volatility-based support and resistance levels allow for a stronger move to the downside.
  • This setup creates an opportunity for traders to profit from unforeseen earnings results.

Option trading is a literal bet on market probabilities. By comparing the details of both stock price and option behavior, chart watchers can gain valuable insight, although it helps to understand the context in which this price behavior took place. The chart below illustrates the share price action for LLY as of Friday, July 30. This created the setup leading into the earnings report.

Earnings pricing for Eli Lilly and Company (LLY)

Current Trends

The one-month trend of LLY stock has the shares ascending into an extreme range. It is notable that, over the past month, the highest LLY share price was near $248 in late July. The lowest share price was roughly $217 in late June. The price closed in the upper region depicted by the technical studies on this chart.

The studies are formed by 20-day Keltner Channel indicators. These depict price levels that represent a multiple of the Average True Range (ATR) for the stock. This array helps to highlight the way the price has moved to a higher range all month. This price move from LLY shares implies that investors expect a positive earnings result.

Tip

The Average True Range (ATR) has become a standard tool for depicting historical volatility over time. The typical average length of time used in its calculation is 10 to 20 time periods, which includes two to four weeks of trading on a daily chart.

In this context where the price trend for Eli Lilly has been rising to an extreme range, chart watchers can recognize that traders and investors are expressing optimism going into earnings. In the week before earnings, LLY's share price reached its all-time high, before slightly pulling back at the end of the week. That makes it important for chart watchers to determine whether the move is reflecting investors' expectations for a favorable earnings report or not.

Option trading details can provide additional context to assist chart watchers in forming an opinion about investor expectations. Recently, option traders are favoring calls over puts by over 2-to-1, as Friday's option volume had a greater number of calls than puts. It should be noted that there are a higher number of puts than calls in the open interest, but it appears that traders are selling these options. Normally, this suggests that investors are expecting a positive earnings report and that traders appear to be expecting LLY to move higher after earnings.

Tip

The Keltner Channel indicator displays a set of semi-parallel lines based on a 20-day simple moving average and an upper and lower line. Because the upper lines are drawn by adding a multiple of ATR to the average and the lower lines are drawn by subtracting a multiple of ATR from the average price, then this channel indicator makes for an excellent visualization tool when charting historical volatility.

Trading Activity

Option traders recognize that LLY shares are in an extreme range and have priced their options as a bet that the stock will close within one of the two boxes depicted in the chart between today and Aug. 6, the Friday after the earnings report is released. The green-framed box represents the pricing that call option sellers are offering. It implies a 37% that Eli Lilly shares will close inside this range by the end of the week if prices go higher. The red box represented the pricing for put options with a 31% probability if prices go lower on the announcement.

It's important to note that the open interest featured over 59,000 active call options compared to roughly 88,000 put options, demonstrating the bias that option buyers had, as well over half of the trades were put options. This amount normally implies that put option traders expect a decline in price, but it should be noted that it appears these put options are being sold, reflecting a bullish outlook. However, because the call box and put box are relatively equal in size, it tells us that the high percentage of options traded has only mildly skewed expectations higher. A far more complacent outlook is implied.

Option pricing for Eli Lilly and Company (LLY)

The purple lines on the chart are generated by a 10-day Keltner Channel study set at four times the ATR. This measure tends to create highly correlated regions of strong support and resistance in the price action. These regions show up when the channel lines make a noticeable turn within the previous three months.

The levels that the turns mark are annotated in the chart below. What is notable in this chart is that the call and put pricing are in such a close range with plenty of space to run downwards compared to upwards. This suggests that option buyers don't have a strong conviction about how the company will report, even though calls are being purchased over puts. Although investors and option traders do not expect it, a surprising report could push prices dramatically higher or lower.

Volatility pattern for Eli Lilly and Company (LLY)

These support and resistance levels show a large range of support and resistance for prices. As a result, it is possible that any news, surprisingly bad or good, will catch investors by surprise and could generate an unusually large move. After the previous earnings announcement, LLY shares fell by 0.91% in the day following and gradually rose the following week, climbing above the 20-day moving average for several weeks. Investors may be expecting the same kind of move in the price after this announcement. With plenty of room in the volatility range, share prices could rise or fall more than expected.

Market Impact

Eli Lilly is one of the largest pharmaceutical companies in the world, so its earnings results may have a direct effect on index prices. No matter what the report says, it will likely have a significant impact on stocks in the health care sector. A positive report could lift other stocks in the sector such as Johnson & Johnson (JNJ), Pfizer Inc. (PFE), or AbbVie Inc. (ABBV). It could also affect exchange traded funds (ETFs) such as State Street's Health Care Sector ETF (XLV) or Invesco's Dynamic Pharmaceuticals ETF (PJP).